Wednesday, March 10, 2010

Over time, one would expect the average selling price of used cars to climb in line with inflation and in line with new car prices. As this chart shows, that is indeed the case, if your time horizon is sufficiently long. Notable exceptions to this occurred in the early 2000s, and then in 2008. The first period was one in which the economy was feeling the after-effects of very tight monetary policy from 1996-2001. Tight money had led to declining commodity prices, declining gold prices, and a very strong dollar. Weak used car prices were reflecting deflationary pressures that were showing up in a lot of asset markets. The second period was dominated by the sudden collapse in confidence and spending that in turn was the fallout from the financial crisis. Prices fell because demand collapsed.

The significant rise in prices over the past year reflect that 1) the effects of the financial crisis have largely passed, 2) demand is coming back, and 3) there is no sign here of any asset price deflation. Markets continue to obsess over deflation risks, yet here is yet another example of how prices are rising. The folks at Manheim have some commentary on the specifics of the used car market here.

8 comments:

it is amazing that you consistently find it encouraging that prices crash and explode as has been the case over the last 10-15 years in assets, commodities, money and other items. why not advocate for price stability and point out that violent swings are a sympton of monetary/fiscal policy extremes.

The scrap-rate for private passenger and light trucks has exceeded new production and consequential new vehicle sales for at least 18 months. Hence the average age of the private passenger and light truck fleet has increased. The increased fleet age is accelerating/add-to the scrap-rate causing scrap rates to increase at an increasing rate.

As the scrap-rate continues to exceed replacement rate (new sales) then total supply is declining. Even though new vehicle sales have been somewhat robust as a percentage year-over-year, you are comparing dismal sales with less dismal sales hence the percentage is somewhat misleading.

If demand for vehicles is merely constant, and the scrap rate exceeds the replacement rate, supply is then declining hence creating an upward price pressure.

However, a supply depletion bubble is moving through time. All else constant, at some point the used car price rise, due to the supply depletion bubble, will cause new vehicle prices with warranties, generally lower maintenance, and the dependability factor to become a medium-to-longer-run “relative cost bargain” vs. a used vehicle.

Hence at some point new vehicles sales should strongly accelerate due to rising used vehicle prices and the phenomena of the “relative price bargain“. The supply depletion bubble, moving through time, leading to the new vehicle relative price bargains would seem to indicate new vehicle sales sustainability for the same period that scrap rates exceeded the replacement rate. In other words, accelerating new car sales should last for a time period at least as long as the scrap rate exceeded the replacement rate which created the supply depletion bubble.

septizoniom: I think you misunderstand me. I'm not advocating for prices to rise. My main point re rising prices is that they refute the deflation argument that seems to have a powerful hold on the market. I'm not surprised prices are rising, given how expansive monetary policy is. I merely want to emphasize that there is a lot of evidence that deflation is a no-show, and therefore than the market is overly pessimistic about the future.

I have repeatedly said that the ideal environment would be one of zero inflation.

WEH: Thanks very much for this, as it expands and clarifies the subject. Auto production has fallen so much for so long that rising fleet age almost guarantees a many-year rebound in new car sales, and it has already started.

Most of the research on scrap rate data vs. new car production appears on pay-for-info sites (member only). However here is an article with data links: http://www.thetruthaboutcars.com/u-s-car-sales-in-2009-worst-in-27-years/

One variable that is likely to slow the start/beginning of the new car sales increase to replace fleet supply (all other things constant) was the acceleration of future consumption into the present that occurred last year with “cash for clunkers”. That ridiculous, very costly, and poorly administered exercise of accelerating future consumption into the present means current demand will remain, at the margin, less robust due to the fact that time marches on and now its the “future”.